JD.com IPO: Approach With Caution (Update 1)

Chinese Internet company JD.com is not all it's cracked up to be, once you dig into the details.

An earlier version of this story said Alibaba vendors receive their money in 14 days and $27 million came from U.S. government incentives. TheStreet regrets these errors.

NEW YORK (TheStreet) -- Investors have done well with Chinese Internet companies such as Baidu (BIDU), Qihoo 360 (QIHU), Sohu.com (SOHU) and a select group of others. However, JD.com may be a different story, once you dig beneath the surface.

JD.com, formerly known as 360buy.com, filed last week to raise $1.5 billion in an initial public offering, the first Chinese company to go public since certain accounting firms were suspended. These include Shanghai-based Pricewaterhouse Coopers Zhong Tian, which was the auditor of JD.com's 2011 and 2012 financial statements included in the company's F-1 filing, similar to an S-1 filing for an American company going public.

The $1.5 billion figure is a placeholder used by underwriters Bank of America and UBS, and may change, subject to demand.

JD.com has big name investors, including Saudi billionaire Prince Alwaleed bin Talal, with a 5% stake, and Tiger Global Management, with a 22% stake, and is trying to position itself as the Amazon.com (AMZN) of China (Amazon already operates a Chinese unit, Amazon.cn). Nonetheless, aspects of the company's financial statement give cause for concern, especially as other Chinese companies, including Alibaba Group Holding, 24% owned by Yahoo! (YHOO), get ready to go public later this year.

JD.com could not be reached for comment for this story, and an Alibaba spokesman declined to say when or if the company would go public, only that it was still evaluating its options.

Revenue growth at Beijing-based JD.com has been exceptionally strong, with the company surpassing $8 billion in revenue for the first 9 months of 2013, on the back of 35.8 million active customer accounts, similar to Amazon's model. Like Amazon, JD.com also has a third-party business, which generated $3 billion in sales.

However, the similarities to Amazon don't stop there. For the first 9 months of 2013, the company claimed a profit of 60 million Reminibi ($10 million USD), but $36 million came from Internet income, and $27 million in Chinese government incentives. JD.com, which has a strained relationship with vendors, does not pay its third-party sellers for up to 60 days, making money off the float between the time of the sale and actually paying the vendor. Conversely, Alibaba pays its partners within 3-5 days, holding the money only to make sure the buyer is happy, according to sources.

Alibaba, via its Taobao and Tmall units, had $160 billion in gross merchandise value in 2012. On Singles Day in Nov. 2013, Alibaba did more than $5.7 billion in payments volume, setting a new record.

JD.com has been struggling to grow its third-party unit business, which accounts for the bulk of the company's profits, similar to Amazon. Unlike Amazon, however, which essentially has no competition in the United States, JD.com competes with Alibaba's Tmall.

Consumer electronics is an intensely competitive business, with companies such as Amazon, Best Buy (BBY), hhgregg (HGG) and others selling their wares to consumers, all with exceptionally low margins. Approximately 85% of JD.com's sales come from consumer electronics. Consumers have been largely loyal to brands such as Apple (AAPL) or Samsung, so it's difficult to see margins getting better over time. Remember, Circuit City filed bankruptcy just a few short years ago, as the company faced the same issues.

JD.com has noted that it's becoming a consumer goods company, similar to Amazon or Alibaba. However, JD.com appears to be more like Best Buy starting up its BestBuy.com initiative, not a typical Internet e-commerce company. With consumer electronics, there are fewer items, and thus inventory management is much simpler, than say, managing women's sweaters or men's boots. This will severely impact the company's cash haul. JD.com had $1.44 billion in cash and cash equivalents at the end of Sept. 2013 but it also had $1.745 billion in accounts payable at the same time, so the company really has a negative cash situation.